By Shannon P. Pratt
An authoritative textual content on rate of capital for either the nonprofessional and the valuation specialist -- now revised and increased In endeavoring to perform sound company finance, there's possibly not anything so severe, nor slippery, as price of capital estimation. the second one variation of rate of Capital: Estimation and functions combines a cutting-edge treatise on rate of capital estimation with an obtainable creation for the nonprofessional. This entire but usable consultant starts off with an exposition of easy thoughts comprehensible to the lay individual and proceeds steadily from basic purposes to the extra advanced tactics quite often present in undefined. New gains of the revised and accelerated moment variation contain chapters on fiscal worth additional (EVA) and reconciling rate of capital within the source of revenue procedure with valuation multiples available in the market method, in addition to improved insurance of rate of capital within the courts and dealing with reductions for marketability. fee of Capital is still an incomparable source for all events attracted to potent enterprise valuation.
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Free cash flow is the relevant cash flow stream because it represents the broadest level of earnings that can be generated by the asset. With free cash flow as the starting point, the owners of a firm can decide how much of the cash flow stream should be diverted toward new ventures, capital expenditures, interest payments, and dividend payments. 1 3953 P-03 8/29/02 2:19 PM Page 20 20 Cost of Capital Basics Empirical Reason for Preferring Net Cash Flow If the Ibbotson Associates data are used to develop an equity discount rate— using either the build-up model or the Capital Asset Pricing Model (CAPM)—the discount rate is applicable to net cash flow available to the equity investor.
3. Estimate a long-term sustainable rate of growth in cash flows from the end of the discrete projection period forward. 4. 7) to estimate value as of the end of the discrete projection period. 5. Discount each of the increments of cash flow back to a present value at the discount rate (cost of capital) for the number of periods until it is received. 6. Discount the terminal value (estimated in step 4) back to a present value for the number of periods in the discrete projection period (the same number of periods as the last increment of cash flow).
3953 P-03 8/29/02 2:19 PM Page 15 Chapter 3 Net Cash Flow: The Preferred Measure of Return Defining Net Cash Flow Net Cash Flow to Equity Net Cash Flow to Invested Capital Net Cash Flows Should Be Probability-Weighted Expected Values Why Net Cash Flow Is the Preferred Measure of Economic Income Conceptual Reason for Preferring Net Cash Flow Empirical Reason for Preferring Net Cash Flow Summary Cost of capital is a meaningless concept until we define the measure of economic income to which it is to be applied.